Institutional complementarities arise in the context of second-best arrangements to overcome market imperfections and failures, such as the under-provision of general human capital, the lack of insurance against aggregate risk, and short time horizons (high discount rates) that all typically arise in a competitive environment.

Implicitly such second-best arrangements change relative prices, but by doing so affect the outcomes on neighbouring markets as well. My work has concentrated on the following three areas in this respect:

Financial and labour market interactions

A firm's sequential decisions regarding its financial structure and hiring its workforce creates interactions between institutional arrangements on financial and labour markets. In particular, these institutions excercise a complementary impact on:

the risk aversion of entrepreneurs and employees

their incentives to invest in specific assets

time horizon of market participants.

When discount rates are high and the time horizon low, institutions

on financial markets - such as provisions that allow concentrated ownership on stockmarkets - may help to lengthen them while at the same time set incentives for trade unions on the labour market to focus on employment growth rather than short-run wage gains. Such an equilibrium proves, however, to be fragile (paper) and subject to institutional cycles in the presence of highly elastic labour supply (paper).

Investment in (firm-)specific assets - such as special human capital, innovative outlays or specific corporate governance structures - play an important role in determining the productivity at the firm level. Institutional arrangements to mitigate any one of the hold-up problems that arise due to the specific nature of these investments will have an immediate impact on the investment returns of all the others. Such complementary institutional solution may, however, loose out on other dimensions - such as higher unemployment rates that can result from trade union activity - so that no globally optimal institutional arrangement is available in the presence of multiple equilibria (paper). Moreover, these multiple peaks that arise in the economic landscape will typically react quite differently to partial changes in the institutional set-up (structural reforms) with considerably different outcomes (paper).

I am currently working on a book where these ideas are developed more fully and different avenues to financial and labour market interactions are discussed. In particular, the different transmission mechanisms through which complementary relations between institutions arise are analysed more thoroughly and the question of institutional ambiguity is brought up that helps to explain why and how institutions - originally set up for a different purpose - may develop complementarities (read more in this draft chapter).

Complementarities on labour markets

Institutional complementarities can also arise among different institutions on the same market. Different labour market institutions, for instance, that affect both the structure of wages and the cost of employment adjustment may increase the incentives for firms to invest in general skills of their employees. This is in particular the case, when collective wage bargaining systems compress the wage structure, thereby creating a rent for firms that invest in the skills of their workforce. Such an incentive is reinforced when firms are constraint in their ability to fire employees by strict employment protection legislation (EPL). Such a complementary relationship between collective wage bargaining systems and EPL proves, indeed, to be empirically relevant in explaining cross- country differences in their innovation specialisation as not all sectors are likely to benefit from such an institutional interaction to the same extent (paper).